Silicon Valley is stupid (which is why it works)

In the past year, I have met with startup founders and government officials around the world. Everywhere I go, people are hungry to know how they can be clever like Silicon Valley. They assume that since I founded PBworks, a private wiki host and home to over two million groups, I must have insight into the smarts that make the Valley work, and they want to implement those good ideas in their regions.

But Silicon Valley works because it is stupid. The intelligence is distributed, and the ultimate arbiter of correctness is the market.

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Let’s start with the startups. You might think that most successful startups begin with some genius’s brilliant idea. The genius shares this idea with a trusted investor who provides money to hire a team. They work really hard, have a big launch and become a success. But this is not how big companies begin. Companies that start this way tend to be good at spending a lot of money and producing useless products.

Successful startups often begin with no idea at all. They start with some friends who simply enjoy building things together, without any specific idea of what they are going to build or how they are going to make money at it. It sounds silly, but that’s exactly how Hewlett-Packard began. Two nerds in a garage. It took them a few years to find their first really good idea, which was to make cheap, high-quality oscilloscopes. Flickr began by working on something else altogether. Twitter came out of the train wreck of a podcasting startup. If a good team goes through enough ideas, they will eventually figure out how to make something that people want to use. Then, they raise money to bring that product to more people and scale it up.

Okay, so startups are dumb, but what about governments? It’s not that hard to believe that governments are dumb. What’s surprising is when that’s a good thing. The U.S. government is not smart enough to pick winners, so startups are treated like regular companies. When I first traveled to Mexico, I was asked whether the U.S. government paid for all or only part of our office space. The entrepreneurs were astonished to find out that my startup got no help whatsoever from the government. We were on our own. Terrifying. In theory, the Small Business Administration is there to help, but it is irrelevant to startups. It’s structured to help a dry cleaning shop purchase another piece of equipment, not help you hire another iOS developer so you can create Angrier Birds.

But what the U.S. government does do is get the heck out of our way. If you want to start a business, you can just go ahead and do it with no forms at all required. This is called a “sole proprietorship.” At the end of the year when you fill out your personal income taxes, you just attach an appendix that says, “Oh yeah, and I run a business and here’s how much money I made or lost.” If you want to incorporate your business, you can do it in about an hour. The form to create a tax ID takes a minute or two to fill out. Dozens of companies compete to offer cheap and easy payroll tax processing that electronically file everything you need with the state and federal governments for a few bucks a month. The government’s role is infrastructure and facilitation.

If government gave special aid to startups, it would need to ensure those startups were performing well, which would require startups to account for their progress or face punishment for wasting taxpayer money. This regular accounting smells like added paperwork. And overhead. Worst of all, it means bureaucrats are making the call about which startups stay and which go. And when bureaucrats have no incentive to pick longterm winners, they might be persuaded to be more lenient to startups that have friends in high places.

Startups funded by a government cannot, politically, afford to fail. But the real way to create new markets is to do the opposite — reduce the cost of failure by eliminating debtors’ prisons, make bankruptcy straightforward, and allow easy incorporation to shield founders’ personal finances somewhat from the failure of their companies. Even success takes too long for governments. Government programs are managed for the next election cycle, while startups usually take much longer than that to be proven out as a success.

So it’s actually much better if government is “stupid” and delegates the intelligence about which startups should thrive and which should die to others. The government should ensure clear and consistent corporate law and taxation, minimal red tape and overhead, fast and effective infrastructure, easy hiring and firing, and should expose itself as a customer of startup products.

The final dumb contingent of Silicon Valley is our awesome, dumb investors.

In many developing ecosystems, I see angels who describe themselves as “smart money.” They want to take 40 percent or more of the company in a seed round to ensure that the entrepreneur does the right thing, and that if the company is successful, the investor benefits richly. They think they will guide the company to success. They want to have a voice in the day-to-day operations of the company, and when they speak, they expect their entrepreneurs to listen.

But investors who take 40 percent of the company in seed rounds are setting themselves up for failure. If the company does well, it’ll need to raise more financing, and new investors will need substantial percentages of the company. With IPOs taking longer than ever, there may be many of these growth rounds. And if 40 percent of the company is in the hands of a seed investor, there’s not enough room for other investors. A Series A venture capitalist will realize this and simply not invest in a company with this kind of structure, meaning the company will not be able to find financing, even if it is very successful. The “smart” seed investor has effectively doomed the company.

Peter Thiel was the first investor in Facebook. He wrote a check for $500,000 and got a board seat and about 10 percent of the company (not 40 percent), but mostly he just told Zuckerberg to not f**k it up. When the company IPOed years later, poor Peter was left with a mere 2.5 percent stake of the company. But I don’t think he was too upset, because that stake was worth a billion dollars, which makes it the most successful seed investment in history. All for just believing in a smart kid and letting him do his thing. Peter was, brilliantly, not “smart money.”

So the best government defers smarts about which startups to invest in to the investors, the investors defer smarts about how to build the company to the startups, and startups defer the wisdom of what would be a good idea to build to the market. The intelligence is distributed, and it works.

David Weekly is the CEO of Oha.na, which helps users create visual newsletters. He is also a startup mentor and has helped found Hacker Dojo, PBworks, Mexican.VC and SuperHappyDevHouse.

There isn’t any societal need for anybody to work hard in this day & age. We could reduce the work week to 20 hours per week without an unreasonable economic mess, actually this’ll solve unemployment as well. We should reduce it to 5-10 hours per week over the longer term.

We should also widen the class of employees to which this reduced work week applies, no more FLSA overtime exemption for creatives, critical people, management, etc. We must however exempt owners from overtime laws, well obviously.

In combination, you could work much less from someone else, but if you join a startup then you could work much harder.

Focusing on Part II of your argument about governments, let’s beware that this kind of ‘benign neglect’ doesn’t become a modus operandi of the past. Every time I drive past Solyndra, my blood boils. And it causes me to think of Chrysler and GM. Really? I wish & hope government would stay the heck out of business. And especially in CA, restrictions and regulations are getting worse and worse in many markets, not just startups. It is not the government’s job to create winners and losers (haha, I almost typed “w(h)iners), but that is what they are increasingly doing. Thank you for reminding us that the market is the smartest, fastest and most responsive way to create successful, good products and weed out not-so-good ideas (failures). Allowing companies to fail is what ensures better products, services and outcomes for everyone, especially if the failures can learn from their mistakes and make something better.

The days of VCs funding an actual company with real products and revenues is over. It was a new philosophy that started about 1995 and like every new hip VC philosophy, it spread around between them all on Sand Hill Rd., etc. Speculation has more upside and less risk than a real company. It’s been a wall street dumping game ever since. I really hope the SEC or someone does something about it because as you saw with face book, the probability of you buying a hyped up stock and losing is very good. Te VC is the only winner. Usually, the founders get some thing out of it . But everyone else loses except the insiders and bribed lobbyists.

we met up few so called Smart Money angels / seeds .. they like the idea everything is great, they come back with we want 25x return and hence we need 30-40%, so subsequent dilutions will still leave us with decent equity ..

Your point about how govt can hellp, In Singapore Govt has extended lot of grants and co-investments to help de-risk investors and VCs. However the missing element for entrepreneurs to jump and take risk — protecting entrepreneurs from going bankrupt and letting companies / ideas fail even as a concept is non existent. Good article

Great article, David. Seems to me the distributed nature of intelligence and individual stupidity are reasons why governmental efforts to engineer artificial Silicon Valleys elsewhere (e.g. Skolkovo) usually fail. They look at the superficial characteristics of the ecosystem and not the underlying dynamics of the actors in them.

Well David E. Weekly I think with all the research you have done and all the work into revolutionizing this adrenal-aline ego seeking pseudo theory is quite articulate. It seems like you have your head squarely and securely up your ass more than you can type. In-fact I suggest you grow up a little bit rather than being some trendy hipster shoving every digital creation up a human users ass. I suggest seeking Jesus if anything sir. Boy, you’re right! Silicon valley is stupid including this stupid article. I bet you’re into population reduction… hmmm.

There’s one big thing missing from this article. Apparently the U.S. government is so smart having developed and approved all sorts of legislation to help startups grow in every possible way, and withdrawn itself from controlling this area of economy. Go find anything like that.

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If only it were MORE so. Unfortunately, the government doesn’t get out of the way enough (taxes, regulations) and it does make stupid investments (Solyndra, and many, many others). Companies always have internal discussions on how to make it easier for their customers to do business with them; government needs to make it easier to BE IN business (get further out of the way).

Exceptional article! Hearing often in political language, ‘go traditional and conservative’ makes one think how obsolete their views and strategy-sing are. The world is in wheel-work of development from the beginning of time. It would be most beneficial to perpetual betterment of the world , to realize, on all levels, when something new is better then ‘old and traditional.’

What is funny is, from France – where I desperatly try to have a startup-style business grow – is that you are describing exactly why France is such a poor place for entrepreneur … I wish FranÃ§ois Hollande would read this !

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I would add that maybe also customers in usa are stupid and so they try stupid products and help to improve them. And that thanks to stupid filmmakers in hollywood. But obviously there is anybody who is not stupid in this story and it’s in silicon valley and not in my town.

David,great article. I have an interesting story about how “Startups funded by a government cannot, politically, afford to fail”.

During the second year of my first startup, we got a 50k government grant to develop a 12 months investment plan.

Five months later, with 15k already spent, rising costs and no traction, we decided it’s best to move on and look for other opportunities.

Not only the government didn’t like, bother to understand nor help us in the situation, but they required us to give back the 15k of the grant we had already spent (even though we spent everything in their approved schedule and items).

It’s amazing how tunnel vision can be mistaken for insight. Just because a few successful social media start-ups like Twitter and Facebook didn’t take government grants doesn’t mean that Silicon Valley doesn’t benefit from strategic technology investments by government. A number of Valley firms, particularly in biotech, benefited from Small Business Innovation Research grants–a program overseen by the Small Business Administration although operated through individual government agencies. A lot of Valley firms also take advantage of small business loans backed by SBA loan guarantees. And there is the famous, although often mis-used, story of how Google sprung out of the invention of the PageRank algorithm, which was funded by a National Science Foundation grant.

Also, investors who take a big cut of equity and shut out the founders isn’t being ‘smart,’ just short-sighted. And a lot of investors take active board positions–they aren’t just passive moneybags.

I see you’re trying to make an analogy to Dave Isenberg’s thesis on the “stupid network,” but distributed intelligence in a market economy is not the same as “dumb switches.” The Valley has a high density of connectors–research labs (usually gov’t-funded), investors, serial entrepreneurs–who are dynamically reconfiguring the network on the fly as they pursue new opportunities. But those connections aren’t dumb–quite the opposite. They just know their limitations.

I do think the government plays an excellent role in startup culture when it exposes itself as a customer. But moreover, in what you wrote there’s a great nugget that sums up much of what I was trying to say – truly smart people know their limitations and double down on the things they’re good at while delegating and empowering others to take care of the rest. Fake-smart people think they’re good at everything and try to take charge of everything and consequently screw things up.

I think mainly it’s about letting smart and curious people do their thing and finding ways to get out of their way. Pretty much every place around the world has smart and curious people, but different regimes, cultures, and educational structures produce different outcomes in terms of their likelihood to constructively contribute to human knowledge.

Thanks for the feedback, and at least I ended up with something on which we could agree! This essay actually came from a talk I gave at Skolkovo Business School in Moscow, so it was intended for a non-SV audience – and I think you will find that outside SV there are still very many geographies in which angels seeking 40% is not an uncommon sight! It would be awesome if that was truly, globally, an outdated funding model. Then our work would be done. Likewise, the passion for seeing what the government does right here didn’t come until I saw how badly “smart” government internationally had botched things. It’s very easy to take for granted how smooth it can be to conduct business in the US!

If you have some other ideas on how to make the point more clearly and concretely, I’m all ears.

Really great point! Here in India, it is routine for Angels (or Demons?) and Series A investors take more than half the company! I have seen plenty of talent get frustrated with so called smart investors then try to micro-manage such companies, because they own so much of the company